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A 401(k) offers a tax-friendly way to save for retirement, but there are limitations. Most plans have a narrow menu of investment options that are chosen by the employer and plan provider. However, some plans allow participants to opt into a self-directed brokerage account. This unlocks a wider selection of investments and more flexibility, but there are potential drawbacks to consider. Here's what you need to know about 401(k) brokerage accounts.
What Are 401(k) Brokerage Accounts?
A 401(k) brokerage account works like a regular brokerage account, except that it operates out of an employer-sponsored 401(k). If your plan offers one, you can use it to expand your investment options and take greater control of your account. It can give you access to more securities like stocks, bonds, mutual funds, exchange-traded funds (ETFs) and more.
A recent PlanSponsor report found that about 23% of 401(k) plans offer this type of "brokerage window." You can move your 401(k) assets into the account without triggering taxes or penalties. From there, you'll be able to trade securities as you would with a normal brokerage account.
How Are 401(k) Brokerage Accounts Different From Traditional 401(k)s?
A 401(k) is a relatively hands-off investment vehicle. If you don't specify your investment choices, the plan will likely choose default investments for you based on your age. These are often target-date funds, which automatically become more conservative as you get closer to retirement. You can also choose securities off your plan's regular investment menu. That typically includes a mix of stock and bond funds.
With a 401(k) brokerage account, you'll have access to a larger menu. That may include more mutual funds and even individual stocks. This allows you to invest in a self-directed way that's aligned with your financial goals and risk tolerance. Check with your employer to see what investment options are available to you and how much of your 401(k) can be included in the brokerage window.
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Pros and Cons of 401(k) Brokerages
Having this type of control over your 401(k) investments has some benefits and downsides.
Pros
- More investment options: You can branch out from your 401(k) plan's default offerings and explore different investments.
- Tax benefits: You can actively buy and sell securities without losing the tax benefits of your 401(k). Regular brokerage accounts don't have these tax advantages.
- Active trading: With a 401(k) brokerage account, you can take a more active role. That includes selecting investments and making trades yourself.
Cons
- Potentially higher costs: Your plan sponsor may charge additional fees for opting into the brokerage window. Frequent trades could lead to higher costs if transaction fees and brokerage commissions come into play. That can deplete your investment returns.
- More risk: Managing some or all of your 401(k) assets yourself could expose you to more risk. Like a regular brokerage account, you'll want to do your research and choose your investments wisely.
- Requires time and energy: Deciding on the right investments will likely take time and research. Otherwise, you could end up making investment choices that don't line up with your desired asset allocation.
When a 401(k) Brokerage May Be Right for You
Self-directed brokerage accounts can offer greater flexibility and hands-on involvement that some investors find refreshing. You'll also have access to a wider selection of investment options. That could be a good fit if you're an investor who likes being in the driver's seat—but self-directed 401(k)s aren't for everyone.
Managing your own investments can be time-consuming and stressful if you aren't prepared, especially if you're a risk-averse investor. You might also incur fees that eat into your investment gains.
The Bottom Line
If your 401(k) plan offers a brokerage window, contact your plan administrator to get the details. You can also consult a financial advisor to see if it's a good option for you. If you decide that it isn't, you could always choose investments from your 401(k) plan's regular menu. The right choice for you depends on your financial situation, risk tolerance and investment preferences.
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